Can a brand-new business avoid a gross receipts tax negligence penalty when it hired an attorney and CPA to guide it but they never mentioned the tax — and does interest still apply?

Plain-English summary

A first-time business that hired an attorney and a CPA to handle its filings but was never told about gross receipts tax had its negligence penalty abated — because the owners exercised ordinary business care by reasonably relying on their professionals. Interest, though, still applied. Protest GRANTED IN PART and DENIED IN PART.

Mary Lou Lopez and Margaret Mulvey opened a Children's Orchard franchise store (through their corporation Kidz Karousel) with no business background. To make sure everything — including taxes — was done right, they hired both an attorney and a CPA and told them plainly they were relying on the professionals to educate them and file all required forms. They even chose to pay for a CPA rather than a bookkeeper. They registered with the Department, received a CRS packet, and hired a payroll service, which agreed to file the monthly CRS-1 returns. Neither the attorney nor the CPA ever mentioned gross receipts tax. Because New Mexico's combined CRS-1 form reports both withholding and gross receipts tax, the owners did not realize the payroll service was reporting only withholding — not their gross receipts tax. The problem surfaced in January 2000 when the CPA finally asked for the gross receipts reports; the owners then filed all back returns and began paying on installments. The Department assessed the tax plus interest and penalty, and the owners protested only the interest and penalty.

Interest is mandatory no matter the reason

Under Section 7-1-67, if tax is not paid when due, interest "shall" be paid until it is — the word "shall" makes it mandatory (State v. Lujan), and interest accrues "without regard to any extension of time or installment agreement." Interest is not a punishment; it compensates the state for the time value of money it was owed. The owners had the use of the state's money during their first eighteen months (and part remained on an installment plan), so interest was properly assessed regardless of why the payments were late.

The penalty was abated — this was diligence, not delegation to a negligent agent

The negligence penalty under Section 7-1-69(A) turns on whether the taxpayer exercised ordinary business care. The Department pointed to Regulation 3.1.11.11(D)'s caveat that failing to timely file "is not excused by the taxpayer's reliance on an agent," and to El Centro Villa, where a negligent accountant's failures were charged to the taxpayer. The hearing officer distinguished those. The payroll service was hired only for payroll/withholding returns and did that job correctly — there was no agent negligence to attribute to the owners. Their failure to file gross receipts returns instead came from genuine unfamiliarity with the tax and with the combined-reporting system that uses one form for both taxes.

Although lack of knowledge is one indicator of negligence, ignorance of the law can be excused when a taxpayer takes reasonable steps to educate itself. These owners did exactly that: aware of their inexperience, they engaged an attorney and a CPA, disclosed that inexperience, and relied on them to explain all obligations, including taxes. That the professionals never raised gross receipts tax — the CPA did not even ask for gross receipts returns when preparing the 1998 income tax return — was the advisers' failing, not the owners' negligence. The situation closely mirrored the reasonable-reliance example in Regulation 3.1.11.11(D), and the hearing officer emphasized that the regulation's eight scenarios are only examples; the ultimate question is whether the taxpayer exercised ordinary business care and prudence. Finding that it had, the hearing officer abated the penalty.

Result: protest GRANTED IN PART (penalty abated) and DENIED IN PART (interest upheld).

What this means for you

Genuinely relying on professionals you hired can defeat a negligence penalty

If you are new to business, hire qualified advisers, tell them the full picture, and reasonably rely on them to identify your obligations, a resulting tax lapse may not be "negligent." Regulation 3.1.11.11's examples are illustrative — the real test is whether you exercised the ordinary care a reasonable taxpayer would. Diligence in getting good advice matters.

But that only works if you actually engaged and disclosed — not just delegated

This is the flip side of cases where the penalty stood. Simply handing everything to an agent, or assuming someone else "has it," is not enough; here the owners specifically retained professionals to educate them and laid out their inexperience. Contrast that with a business that merely delegated filing and never engaged — that is negligence.

Know that one CRS-1 form covers two different taxes

New Mexico's combined CRS-1 return reports withholding and gross receipts tax. A payroll service filing your withholding does not necessarily report your gross receipts tax. Confirm exactly which lines and which taxes anyone filing for you is actually covering.

Interest will not be abated even when the penalty is

Interest is automatic under Section 7-1-67 and runs even on installment agreements. Even a sympathetic, non-negligent taxpayer owes it, because it just compensates the state for the delay. Expect to pay interest on any late tax.

Common questions

Q: What did the owners contest, and what did they win?
A: They accepted the gross receipts tax principal and protested only the interest and penalty. The penalty was abated; the interest was upheld.

Q: Why was the penalty abated?
A: Because the owners exercised ordinary business care — they hired an attorney and CPA, disclosed their inexperience, and reasonably relied on them. Their failure to file gross receipts returns stemmed from that reliance and from confusion over the combined CRS-1 form, not from negligence.

Q: Wasn't relying on the payroll service "reliance on an agent," which the regulation says doesn't excuse a late filing?
A: The hearing officer distinguished that. The payroll service was hired only for withholding returns and did them correctly — there was no agent negligence to attribute. The gross receipts gap came from the owners' lack of knowledge despite reasonable efforts to get advice.

Q: How is this different from cases where the penalty was upheld?
A: Merely delegating tax duties to an agent who then fails does not excuse a taxpayer (as in El Centro Villa). Here the owners actively engaged professionals and disclosed their situation, which the hearing officer treated as ordinary business care rather than negligent delegation.

Q: Why did interest still apply?
A: Section 7-1-67 makes interest mandatory on late tax, even with an installment agreement, because it compensates the state for the time value of the money. The reason for the delay does not matter.

Citations and references

Statutes and regulations:

• NMSA 1978, § 7-1-69(A) — negligence penalty (2% per month, up to 10%) for failing to pay or file tax when due
• NMSA 1978, § 7-1-67 — interest on late-paid tax is mandatory ("shall"), accruing without regard to any extension or installment agreement
• NMSA 1978, § 7-1-17(C) — a Department assessment, including interest and penalty, is presumed correct
• NMSA 1978, § 7-1-3(X) — "tax" includes related interest and civil penalty
• Regulation 3.1.11.10 NMAC — definition of taxpayer negligence
• Regulation 3.1.11.11 NMAC — illustrative non-negligence situations, including reasonable reliance on competent counsel's or an accountant's advice as to liability after full disclosure

Cases cited:

• State v. Lujan, 90 N.M. 103, 560 P.2d 167 (1977)
• El Centro Villa Nursing Center v. Taxation and Revenue Department, 108 N.M. 795, 779 P.2d 982 (Ct. App. 1989)

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Kidz Karousel Inc.,d/b/a Children’s Orchard
• Decision PDF: D&O 01-15

Original ruling text

BEFORE THE HEARING OFFICER
OF THE TAXATION AND REVENUE DEPARTMENT
OF THE STATE OF NEW MEXICO

IN THE MATTER OF THE PROTEST OF
KIDZ KAROUSEL, INC. d/b/a No. 01-15
CHILREN’S ORCHARD
ID NO. 02-361614-00 8
ASSESSMENT NOS. 2532927 through 2532933

DECISION AND ORDER

A formal hearing on the above-referenced protest was held July 25, 2001, before Margaret B.

Alcock, Hearing Officer. Children’s Orchard was represented by Mary Lou Lopez and Margaret

Mulvey, its owners (referred to as “Taxpayers”). The Taxation and Revenue Department (referred to

as "Department") was represented by Javier Lopez, Special Assistant Attorney General. Based on the

evidence and arguments presented, IT IS DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. “Children’s Orchard” is a franchise of retail clothing stores.

2. In May 1998, the Taxpayers formed the corporation Kidz Karousel, Inc. for the

purpose of opening a store under the Children’s Orchard franchise.

3. The Taxpayers did not have any business background or knowledge of tax or

financial matters. For this reason, they hired an attorney and a certified public accountant (“CPA”)

to advise them.

4. The Taxpayers explained their lack of business experience to the attorney and CPA

and said they were relying on their advisers to educate the Taxpayers on business procedures and to

insure the Taxpayers filed all required legal forms, including tax forms.

5. The Taxpayers had considered hiring a bookkeeper for the business, but decided to

spend the extra money for a CPA to insure that all taxes were properly reported and paid.

6. The CPA gave them a list of the documents he would need to prepare the business’s

income tax returns. Neither the CPA nor the attorney ever discussed gross receipts tax with the

Taxpayers.

7. In addition to hiring an attorney and CPA, the Taxpayers consulted with the New

Mexico Business Resource Center, and it was someone at the Center who told the Taxpayers they

needed to obtain a tax identification number from the Department.

8. The Taxpayers registered the business with the Department and were given a tax

identification number to be used for payment of gross receipts, compensating and withholding taxes

under the Department’s combined reporting system (“CRS”).

9. The Taxpayers were also given a CRS packet that contained the CRS-1 forms used to

report gross receipts, compensating and withholding taxes each month.

10. The Taxpayers hired a payroll service to handle their payroll taxes. When they

received the CRS packet from the Department, Ms. Lopez called the payroll company and asked

whether the company would be filing CRS-1 returns for the Taxpayers’ business.

11. The payroll service said they would file the CRS-1 returns and told Ms. Lopez to

forward the CRS packet to them. Thereafter, Ms. Lopez sent the CRS packets the Taxpayers

received from the Department to the payroll service.

12. In January 1999, the Taxpayers met with their CPA to go over the information

needed to file the business’s 1998 corporate income tax returns. Although gross receipts taxes may

be taken as an expense against business income, the CPA did not ask for copies of the Taxpayers’

gross receipts tax reports.

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13. In January 2000, the Taxpayers met with their CPA to go over the information

needed to file the business’s 1999 corporate income tax returns. This time, the CPA asked for copies

of the monthly gross receipts tax reports.

14. The Taxpayers told the CPA that the payroll service was filing their monthly CRS-1

returns, but subsequently discovered that the CRS-1 returns filed by the payroll service included only

withholding tax and did not report the Taxpayer’s gross receipts tax liability.

15. The Taxpayers did not understand why the CPA had not discussed the gross receipts

tax with them during prior meetings and asked the CPA why the issue had not come up when he

prepared the business’s 1998 income tax returns the year before. The CPA gave a somewhat evasive

answer, saying that the appropriate adjustments had been made on the Taxpayer’s 1998 income tax

return. From this, the Taxpayers concluded that the CPA had simply estimated the previous year’s

gross receipts tax deduction.

16. After the Taxpayers’ filing problems came to light, their CPA offered to have

someone on his staff walk the Taxpayers through the steps needed to complete the CRS-1 returns.

17. The Taxpayers made an appointment to meet with someone in the Department’s

Albuquerque office. After the meeting, the Taxpayers filed all back gross receipts tax returns and

began making monthly payments on their outstanding tax liability.

18. On May 23, 2000, the Department issued assessments to the Taxpayers’ business for

unpaid gross receipts tax, plus interest and penalty.

19. On May 23, 2000, the Taxpayers filed a protest to the interest and penalty assessed.

20. After the assessments were issued, Ms. Lopez told the Taxpayers’ attorney about the

business’s tax problems. The attorney indicated to Ms. Lopez that he should have discussed the

gross receipts tax with the Taxpayers when they first set up the corporation.

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DISCUSSION

The issue to be decided to whether the Taxpayers’ corporation is liable for the interest and

penalty assessed by the Department. The Taxpayers do not dispute their liability for the tax

principal, but maintain it is unfair to assess them interest and penalty because they took all reasonable

steps to insure compliance with the state’s tax laws and should not be penalized for the failure of

their attorney and CPA to properly advise them.

Section 7-1-17(C) NMSA 1978 provides that any assessment of taxes made by the

Department is presumed to be correct. Section 7-1-3(X) NMSA 1978 defines tax to include not only

the amount of tax principal imposed but also, unless the context otherwise requires, “the amount of

any interest or civil penalty relating thereto." Thus, the presumption of correctness of an assessment

of taxes also applies to the assessment of interest and penalty. El Centro Villa Nursing Center v.

Taxation and Revenue Department, 108 N.M. 795, 779 P.2d 982 (Ct. App. 1989).

Interest. Section 7-1-67 NMSA 1978 governs the imposition of interest on late payments of

tax and provides, in pertinent part:

A. If any tax imposed is not paid on or before the day on which it
becomes due, interest shall be paid to the state on such amount from the
first day following the day on which the tax becomes due, without
regard to any extension of time or installment agreement, until it is
paid...

The legislature’s use of the word “shall” indicates that the assessment of interest is mandatory rather

than discretionary. State v. Lujan, 90 N.M. 103, 560 P.2d 167 (1977). The legislature has directed the

Department to assess interest whenever taxes are not timely paid and has provided no exceptions to the

mandate of the statute. The assessment of interest is not designed to punish taxpayers, but to

compensate the state for the time value of unpaid revenues.

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In this case, the Taxpayers failed to pay gross receipts tax during the first eighteen months

they were in business. Although the Taxpayers’ failure to pay tax was not intentional, the fact

remains that the Taxpayers had the use of the state’s money during this period. Even now, a portion

of the gross receipts tax is still outstanding and is being paid on an installment basis. Section 7-1-67

NMSA 1978 specifically provides that interest accrues on unpaid tax “without regard to any

extension of time or installment agreement”. As this illustrates, the reason for a late payment of tax is

irrelevant. Interest must be paid for any period of time during which the state is denied the use of the

funds to which it is entitled. Accordingly, interest was properly assessed against the Taxpayers and

there is no basis for abatement.

Penalty. Section 7-1-69 NMSA 1978 governs the imposition of penalty. Subsection A

imposes a penalty of two percent per month, up to a maximum of ten percent, when a taxpayer fails

“due to negligence or disregard of rules and regulations” to pay taxes in a timely manner. Taxpayer

negligence for purposes of assessing penalty is defined in Regulation 3.1.11.10 NMAC as:

A. failure to exercise that degree of ordinary business care and
prudence which reasonable taxpayers would exercise under
like circumstances;

B. inaction by taxpayers where action is required;

C. inadvertence, indifference, thoughtlessness, carelessness,
erroneous belief or inattention.

In this case, the Taxpayers maintain that by consulting with both an attorney and a CPA concerning

their business and tax filing obligations, they exercised a sufficient degree of ordinary business care

and prudence to establish nonnegligence under Regulation 3.1.11.10(A) NMAC. The Department

disputes that the Taxpayers’ actions met the nonnegligence requirements of Regulation 3.1.11.11(D)

NMAC, which provides that a taxpayer will not be considered negligent where:

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D. the taxpayer proves that the failure to pay tax or to file a return was
caused by reasonable reliance on the advice of competent tax counsel or
accountant as to the taxpayer’s liability after full disclosure of all relevant
facts; failure to make a timely filing of a tax return, however, is not
excused by the taxpayer’s reliance on an agent.

Relying on the last sentence of the regulation, the Department maintains that the Taxpayers’ failure to

file gross receipts tax returns cannot be excused by their reliance on the payroll service to file their

CRS-1 returns.

The Department is correct in its position that merely delegating tax responsibilities to an

accountant or other agent is not sufficient for a taxpayer to escape the imposition of penalty when the

agent is negligent in performing his duties. The negligent acts of an agent are attributable to the

taxpayer. This was the holding of the Court of Appeals in El Centro Villa Nursing Center v. Taxation

and Revenue Department, 108 N.M. 795, 779 P.2d 982 (Ct. App. 1989), which upheld the imposition

of penalty on a taxpayer who delegated its obligation to prepare and file tax returns to an accountant. In

that case, the taxpayer received unusually large Medicaid payments as a result of reimbursement

adjustments made by the Human Services Department. Although the taxpayer reported gross receipts

tax on its normal Medicaid payments, it failed to report and pay tax on the adjustment payments. The

court found negligence on the part of both the taxpayer and its accountant. The finding of negligence by

the taxpayer was based on the taxpayer’s failure to alert its accountant to the unusual payments and the

nature of those payments. The court found that the accountant was negligent in failing to implement an

accounting system in such a way that checks and balances in the system would have alerted the

accountant to the unusual income items so they could be examined and reported properly for tax

purposes.

The facts of this case are quite different than those in El Centro Villa. Here, the Taxpayers’

failure to pay gross receipts tax was not attributable to their delegation of authority to the payroll

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service. The payroll service had been hired as the Taxpayer’s agent to prepare and file returns relating

to the Taxpayers’ payroll, which included withholding and employment taxes. The payroll service

performed these duties correctly, and there was no negligence on its part that could be attributed to the

Taxpayers. The Taxpayers’ failure to file gross receipts tax returns resulted from the Taxpayers’ lack

of knowledge concerning the gross receipts tax and the mechanics of the Department’s combined

reporting system, which uses the same form to report both withholding and gross receipts tax. The

Taxpayers did not understand that even though the payroll service was filing monthly CRS-1 returns to

report withholding tax, the Taxpayers had to file separate CRS-1 returns to report their gross receipts

tax.

Although lack of knowledge is one of the indications of negligence set out in Regulation

3.1.11.10 NMAC, a taxpayer’s ignorance of the law may be excused when the taxpayer has taken

reasonable steps to educate himself concerning his tax liabilities. In this case, the Taxpayers were well

aware they lacked the knowledge and experience needed to run a business and attempted to remedy the

situation by engaging the professional services of an attorney and an accountant. The Taxpayers

considered hiring a bookkeeper to advise them, but ultimately decided to incur the extra expense of

hiring a CPA to insure their taxes were properly reported. Unfortunately, neither the attorney nor the

CPA ever discussed the gross receipts tax with the Taxpayers or explained their reporting obligations.

Particularly troubling is the failure of the CPA to ask for copies of gross receipts tax returns when

preparing the Taxpayers’ 1998 income tax returns. Gross sales reported for income tax purposes may

not be an accurate basis for determining the amount of gross receipts tax paid since a business is often

entitled to claim deductions and exemptions that serve to reduce taxable receipts. Also troubling is the

fact that the CPA waited until after the Taxpayers’ filing problems came to light before offering to have

someone on his staff walk the Taxpayers through the steps needed to complete the CRS-1 returns. If

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this had been done when the Taxpayers first opened their business, none of the current problems would

have arisen.

The Taxpayers’ experience is very similar to the situation set out in Regulation 3.1.11.11(D)

NMAC, which supports a finding of nonnegligence based on a taxpayer’s “reasonable reliance on the

advice of competent tax counsel or accountant as to the taxpayer’s liability after full disclosure of all

relevant facts.” In dealing with their attorney and accountant, the Taxpayers made no secret of their

lack of business knowledge. They made it clear they were relying on their advisors to walk them

through the procedures to be followed in operating the business and to advise them on their legal

obligations, including tax obligations. Although these facts are slightly different than those in the

Department’s regulation, the eight scenarios set out in 3.1.11.11 NMAC are only examples. There are

many situations that will support a finding of nonnegligence. The ultimate question is whether a

taxpayer has exercised ordinary business care and prudence with respect to its obligation to timely

report and pay taxes, not whether the situation exactly mirrors the hypothetical fact patterns described

in the Department’s regulations.

Based on the facts presented, the Taxpayers exercised the degree of ordinary business care and

prudence which reasonable taxpayers would exercise under like circumstances and the assessment of

penalty should be abated.

CONCLUSIONS OF LAW

1. The Taxpayers filed a timely, written protest to Assessment Nos. 2532927 through

2532933, and jurisdiction lies over the parties and the subject matter of this protest.

2. Pursuant to Section 7-1-67 NMSA 1978, interest was properly assessed against the

Taxpayers on the late payment of gross receipts taxes.

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3. Pursuant to Section 7-1-69 NMSA 1978 and the Department’s regulations, the

Taxpayers were not negligent in failing to report gross receipts tax during the period at issue.

For the foregoing reasons, the Taxpayer's protest IS DENIED IN PART AND GRANTED IN

PART. The Department is hereby ordered to abate the penalty portion of Assessment Nos. 2532927

through 2532933.

DATED August 1, 2001.

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